Police and military troops swiftly surrounded the hotel in the Red Sea resort city of Eilat after the man - a former employee of the hotel - "grabbed a weapon from a security guard and shot a hotel worker," police spokesman Micky Rosenfeld said.

The man barricaded himself in the hotel kitchen, shooting back at law enforcement officers. He was shot dead by members of a military counter-terrorism squad, a military source said.

An Israeli hotel guest, Aviram Sela, said he tried to wrestle the gunman to the ground before he started shooting, as terrified tourists dived for cover behind a sofa in the hotel lobby.

"We saw him beating the guard and grab his weapon and the magazine," Sela told Israeli television, adding that the gunman then took aim at a member of his family.

Israeli Defense Minister Ehud Barak told Army Radio the incident "appears to be an internal dispute".

Eilat, on the border with Egypt and Jordan, has been a target of militant attacks in the past, and has come under rocket fire from Egypt's Sinai in the past several months. The city is currently crowded with both foreign tourists and Israelis on a seven-day Jewish religious holiday.